DOMESTIC TRANSFER PRICING
CA Jiger Saiya
12 October 2014
WIRC of ICAI: J B Nagar CPE Study Circle
DOMESTIC TRANSFER PRICING
INTRODUCTION
[ 3]
COVERAGE & IMPLICATIONS
[ 8]
DOCUMENTATION & CERTIFICATION
[15]
ISSUES & CASE STUDIES
[29]
KEY TAKEAWAYS
[40]
CA Jiger Saiya
Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Introduction
CA Jiger Saiya
INTRODUCTION
Background & Relevant Amendments
• TP provisions have been traditionally applied only to ‘international transactions’
• Taking cue from Supreme Court’s suggestion in case of GlaxoSmithkline Asia (P) Ltd, Finance Act 2012 has
extended TP provisions to ‘Specified Domestic Transactions’ (SDTs), including:
-
Payment to Related Parties, covered under Section 40A(2)(b)
Inter-unit transactions by units covered under Section 80-IA, 80-IB, 80-IC, 80-ID, 80-IE, SEZ units and SEZ Developers
Intra-group transactions by taxpayers covered under Section 80-IA, 80-IB, 80-IC, 80-ID, 80-IE, SEZ units and SEZ
Developers
Other prescribed transactions
• TP Regulations apply if sum of above transactions exceed Rs. 5 Cr.
• Corresponding amendments also carried out in relevant sections
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Domestic Transfer Pricing
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INTRODUCTION
Tax Arbitrage Between Related Parties
Sale of Goods
A Ltd
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Domestic Transfer Pricing
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100%
B Pvt. Ltd.
INTRODUCTION
Tax Arbitrage for Tax Holiday Units
Sale of Goods
A Ltd – Unit 1
(Eligible Unit)
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Domestic Transfer Pricing\
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100%
A Ltd – Unit 2
(Ineligible Unit)
DOMESTIC TRANSFER PRICING
Coverage & Implications
CA Jiger Saiya
DOMESTIC TRANSFER PRICING
Coverage
•
All payments to Specified Persons as per Section 40A(2)
-
•
Purchase of goods / services
Management fees / royalties
Interest payments on loans taken from Related Parties / guarantee fees paid to related parties
Purely domestic transactions - Managerial Remuneration, payment of rent, equipment hire etc.
Cost allocations
Specific Transactions for Tax Holiday Taxpayers
-
Transfer of goods and services between tax holiday unit and another unit
Any business transacted with any person, where such business produces more than ordinary profits eligible for tax
holiday; owing to ‘close connection’ or any other reason
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Implications
•
Compliance requirements
-
•
Transfer Pricing Benchmarking
-
•
•
Any of the 6 methods can be used, provided it is Most Appropriate Method
Scrutiny by TPO
Corresponding Adjustments may not be allowed
-
•
Documentation and Form 3CEB
Burden of Proof on the Taxpayer
Poor Transfer Pricing would lead to additional tax cost
Deadlines for compliances and scrutiny
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Differences between pre and post amendment scenarios
Area of Difference
Pre-Amendment
Post-Amendment
Concept
Fair Value / FMV
Arm’s Length Price
Nature
Open / flexible
Systematic / static
Ad-hoc adjustments
Commonly being made
Should be avoided
Burden of Proof
Revenue
Taxpayer
Approach of Taxpayer
Reactive
Proactive
Compliance Burden
Basic Reporting in TAR
Onerous
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Differences between pre and post amendment scenarios
Area of Difference
Pre-Amendment
Post-Amendment
Cost based analysis
Accepted / not accepted
Accepted
Tax Evasion
Relevant
Not Relevant
Managerial Remuneration
Broad Justification
Justification of amounts
High Interest Paid
Nexus with loan given
Nexus not required
Tax Holiday Units
ALP not relevant
ALP specifically applied
AE as Comparables
Allowed / not allowed
Not allowed
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Differences between International & Domestic Transfer Pricing
Area of Difference
International
Domestic
International Guidance
Available
Not Available
APA
Available
Not Available
Managerial Remn / Rent
Not Applicable
Applicable
Threshold for compliance
NIL
INR 5 Crores
Tested Party
Preferably Taxpayer
Taxpayer or other party
Revenue Loss to Govt.
Generally Relevant
Not Always Relevant
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DOMESTIC TRANSFER PRICING
Differences between International & Domestic Transfer Pricing
Area of Difference
International
Domestic
Applicability
Associated Enterprises
Related Parties
Ownership Threshold
26%
20%
Transactions Covered
All Transactions
Limited Transactions
ALP Options for Interest
LIBOR / Eurobor / Rupee
Only Rupee Denomination
Forex Fluctuations
Relevant
Not Applicable
Reporting / Form 3CEB
Practically easier
Needs modification
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Documentation & Certification
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TRANSFER PRICING DOCUMENTATION
Regulatory Requirement
Industry Profile
Group Profile
Profile of Indian Entity
Profile of AE
- FAR (functions, assets and
risks) Analysis
- Agreements
- Invoices
- Pricing related
correspondence (letters,
emails, etc)
Price Related
-
Transaction
Related
Section 92D of the IT Act r.w. Rule 10D of the IT Rules casts an obligation on the Taxpayer to maintain contemporaneous
documentation with respect to the International Transactions and/or Specified Domestic Transactions:
Entity Related
•
- Terms of Transaction
- Economic Analysis
(method selection,
comparable benchmarking)
- Forecasts, Budgets,
Estimates, etc
•
Section 92BA of the Income Tax Act exempts the taxpayer from any compliance with regards Specified Domestic
Transactions where the aggregate value of such transactions do not exceed Rs. 5 Cr.
•
Documentation is to be maintained for a period of 8 years from end of Assessment Year and ought to be produced before
the Tax Office within 30/60 days from date of receipt of notice
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TRANSFER PRICING DOCUMENTATION
Contemporaneous Documentation
•
Rule 10D(4) of IT Rules requires that the information & documentation specified under the Rule 10D should as far as
possible be contemporaneous and should exist latest by the due date of filing of the Return of Income
•
The word ‘contemporaneous’ has not been defined under the IT Act
•
Random House Webster's Unabridged Dictionary defines the word Contemporaneous as “living or occurring during the
same period of time”, "Concurrent", "Consistent", "Simultaneous".
•
From the above it can be inferred that the documentation should be present or should be created at the time the
Taxpayer is entering into an International Transaction or Specified Domestic Transaction with an AE
•
Contemporaneous Documentation Issues
-
Availability of data while entering into controlled transaction / due date of filing of Return of Income (Extended due date for Transfer
Pricing Cases)
-
Use of earlier years data
-
Use of multiple years data
-
Updation of Databases – Fresh Search by TPO
-
Restatement of Financials
-
Difference in financial year
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Domestic Transfer Pricing
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TRANSFER PRICING DOCUMENTATION
Best Practices - Documentation
Master File
Transaction File
General
Agreements &
Invoices
Characterisation
& Analysis
Assumptions
Representation
related
Policy Related
FAR Related
Benchmarking
Notes
Litigation
Support
Pricing Related
Justification
Undertaking &
Representation
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TP Study
TP Certification
TP Assessment
TRANSFER PRICING DOCUMENTATION
Best Practices – Transfer Pricing Study
International / Specified
Domestic Transactions
with AE(s)
FAR Analysis
Industry Overview &
Impact on International
Transactions
Selection of Tested
Party
Identification of
Comparable
Uncontrolled
Transactions
Selection of the Most
Appropriate Method
Indicator Ratios
Functional Adjustment
Group & Taxpayer
Background
Arm’s Length Price
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Domestic Transfer Pricing
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TRANSFER PRICING CERTIFICATION
The Process
Determination of
years to be covered
Analysis of Taxpayers
circumstances
Understanding of
controlled
transaction based on
FAR
Review of internal
comparables, if
existing
Identifying sources
for external
comparables, if
existing
Selection of the most
appropriate method
and PLI
Identification of
potential
comparables
Determination of and
making comparability
adjustments
Interpretation and
use of data
collected,
determination of ALP
Transfer Pricing
Documentation
Transfer Pricing Certification (Form 3CEB)
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Domestic Transfer Pricing
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TRANSFER PRICING CERTIFICATION
Form No 3CEB
•
•
•
Section 92E of the Income Tax Act requires every person who has entered into an international transaction or a specified
domestic transaction to obtain a report from an accountant
Rule 10E prescribes the requisite report to be furnished in Form No. 3CEB
Form No 3CEB
Annexure to Form No 3CEB
Examination of accounts & records
Part A: General Information
Maintenance of prescribed information &
documents
Part B: International Transactions
Factual accuracy of contents mentioned in
annexure to form 3CEB
Part C: Specified Domestic Transactions
While certifying in the Report consider the following
-
Make appropriate disclosure of judicial pronouncement relied upon
Follow Accounting Standard, ICAI Guidance Notes & Standards on Auditing issued by ICAI
Obtain written representation for positions and assumptions
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TRANSFER PRICING CERTIFICATION
Annexure to Form 3CEB
Part C – Specified Domestic Transactions
21. List of associated enterprises with whom the assessee has entered into specified domestic transactions
-
Name, Address and PAN of the associated enterprise
-
Relationship with associated enterprise
-
Brief description of the business of associated enterprise
22. Transactions in the nature of payment for any expenditure to persons referred to in section 40A(2)(b)
23. Transfer or acquisition of any goods or services to/from eligible business of the same assessee
24. Any business transacted by an eligible business
25. Any other transaction
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TRANSFER PRICING CERTIFICATION
Check Points for the TP Auditor and Taxpayer
Coverage of Relationships
• Check for completeness and correctness
• Check points
Coverage of Transactions
• Reconciliation with disclosures
- Notes to Accounts [AS-18]
- Previous year’s form 3CEB
- Tax Audit Report [Section 40A(2)(b)]
- Financial Statements
- Cost Audit Report
- Notes to Accounts – AS 18 disclosures
- Register under Section 301 of Companies Act
- Form 3CD – Sec. 40A(2)(b) disclosures
• Ledger scrutiny
- Cost Audit Report of the company
- Ledger of Party Concerned
- Company / group website
- Transaction Ledger
- Register under Section 301 of Companies Act
• Reconciliation with amounts as per Financial Statements
- Management discussion and representation
• Management discussion and representation
- Relevant Income tax forms
• Details of foreign exchange transactions as provided in the
audited accounts
- Shareholding pattern as per Members Register and Annual
Return
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TRANSFER PRICING CERTIFICATION
Roles and Responsibilities
Taxpayer
Auditor
•
•
Independence in Audit work
•
Clearly defined Scope of examination
•
Recognition of parties and transactions where transfer
pricing applies
Determination of the most appropriate transfer pricing
methodology
-
Recognizing comparable transactions / entities, as much as is
relevant from TP perspective
-
Providing relevant industry-level and market-level
information, such as key markets, major customers,
competitors etc.
-
Providing insight into price-setting mechanism
•
Determination of Arm’s Length Price
•
Compilation of relevant documents as proof of Arm’s
Length Price on real time basis
•
Maintenance of transfer pricing documentation (as per
section 92D r.w. Rule 10D)
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Domestic Transfer Pricing
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-
Importance of signed engagement Letter
•
Management Representation Letter
•
Communication with outgoing auditor
•
Adherence to Code of Conduct
•
Adherence to Guidance Note
•
Quality control and peer review
•
Timely issuance of the Accountant’s Report (Form 3CEB)
to client
•
Maintenance of client file and documentation
•
Disclaimer in Documentation
TRANSFER PRICING CERTIFICATION
Practical Issues
•
•
Availability of contemporaneous data
Comparability differences
-
•
•
Aggregation or standalone evaluation of transactions
Lack of clarity regarding nature of transaction
-
•
Services v Cost allocation
Mutual agreement v Business restructuring
Lack of Information available with client
-
•
Cyclical Issues
Geographical differences
Quantity differences
Differences in terms of transaction
Currency of transactions
Lack of records maintained
Transactions undertaken in absence of agreements
Confidential Agreements
Reliance on previous year’s benchmarking and analysis
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Issues & Case Studies
CA Jiger Saiya
DOMESTIC TRANSFER PRICING
Relationships Covered u/s 40A(2)
Any Taxpayer
• Specified Persons as per Section
40A(2)(b)
Tax Holiday Taxpayer
• Any other eligible or non-eligible unit
of the same Taxpayer
Tax Holiday Taxpayer
• Any person with whom the course of
business is so arranged, which results in
excess profits in the tax holiday unit –
either due to close connection or any
other reason
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Domestic Transfer Pricing
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DOMESTIC TRANSFER PRICING
Relationships Covered u/s 40A(2)
•
100%
B Pvt Ltd
100%
C Pvt Ltd
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Domestic Transfer Pricing
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A Ltd
100%
D Pvt Ltd
Is Domestic TP applicable in case where there is payment
of expenditure by:
- B to A?
- C to A?
- D to B?
- B to C?
- D to A?
- D to C?
- A to B?
DOMESTIC TRANSFER PRICING
Relationships Covered for Tax Holiday Units
Head
Office
Eligible Unit
u/s 80IA
Head
Office
Other Unit
Eligible Unit
u/s 80IC
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Domestic Transfer Pricing
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Other Person
Eligible Unit
u/s 80IA
Other Unit
DOMESTIC TRANSFER PRICING
Applicability to Trusts and co-operative societies
•
Domestic Transfer Pricing applicable to all assesses under the Act
•
Whether payments by a taxpayer to a trust or co-operative society covered?
•
Few Court rulings have held trusts and co-operative societies to be outside the scope of 40A(2)(b)1
•
However, Sub-clause (vi) of section 40A(2)(b) makes a reference to ‘any person who carries on a business or
profession’.
•
Therefore, in a case where a trust or co-operative society carries on ‘Business or Profession’, whether payments made
to such trust or co-operative society, in whose business the taxpayer has substantial interest, could said to be covered
within the ambit of sub-clause (vi) of section 40A(2)(b)
_________________________________________________________________________
1
See, Shanker Trading (P.) Ltd. v. Commissioner of Income tax (2012) IT Appeal No. 53 of 2000 & Others (Delhi), Commissioner of Income tax v.
ManjaraShetkariSahakariSakharKarkhana Ltd. (2008) 166 Taxman 287 (Bom.)
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DOMESTIC TRANSFER PRICING
Transactions Covered
Specified Persons
Any payments of
expenditure to
related parties
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Tax Holiday Taxpayer
Inter-unit transfer of
goods or services
Tax Holiday Taxpayer
Any business
transacted between
the taxpayer and the
other person
DOMESTIC TRANSFER PRICING
Transactions Covered
Capital Expenditure
• Whether capital expenditure covered within the ambit of domestic transfer pricing
• Section 92BA(i) refers to ‘any expenditure’, without making a specific exclusion for Capital Expenditure
• Inference may be drawn from other provisions of the Act where capital expenditure has been specifically excluded (For
instance, Section 37)
• Whether assets acquired on merger/demerger, where consideration paid by issue of equity shares, covered under
domestic transfer pricing?
Expenses relating to ‘Income from other sources’
• Provisions of domestic transfer pricing make reference to persons covered under 40A(2)(b) and not expenditure
domestic transfer pricing
• Accordingly, provisions of domestic transfer pricing could apply to expenses incurred in relation to ‘Income from other
sources’ also
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DOMESTIC TRANSFER PRICING
Transactions Covered
Allocation of corporate costs
• Whether allocation of corporate costs such as managerial remuneration between the eligible and non-eligible units of an
assessee would be subject to domestic transfer pricing?
•
One view is that the ‘goods or services’ transferred ought to have been held for the ‘purpose of the business’
•
Another view is that legislative intention of introduction of domestic transfer pricing was to check tax evasion through
mispricing of intra-unit transfer of goods or services and hence all intra-unit transactions ought to be covered including
allocation of corporate costs
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DOMESTIC TRANSFER PRICING
Transactions Not Covered
Tax Rate = 30%
Scenario 1
Particulars
Scenario 2
A Ltd.
B Pvt. Ltd.
Sale to Related Party
3000
-
Sale to third parties
5000
A Ltd.
B Pvt. Ltd.
Sale to Related Party
1000
-
4000
Sale to third parties
5000
4000
-
3000
Purchase from Related Party
-
1000
Other Expenses
2000
3000
Other Expenses
2000
3000
Profit/ Loss
6000
-2000
Profit/ Loss
4000
NIL
Tax
1800
NIL
Tax
1200
NIL
Purchase from Related Party
Total Tax for the Group
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1800
Particulars
Total Tax for the Group
1200
DOMESTIC TRANSFER PRICING
Director’s Remuneration
X Ltd
Rs.X
Mr A
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Domestic Transfer Pricing
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•
Benchmarking of Director’s Remuneration (Rs.3X paid to
Director – Mr.B)
- Rs.X paid to other Director – Mr.A?
- Rs.7X paid by Y Ltd. to Director – Mr.C?
•
Incase of increase in remuneration – previous years value
comparable?
•
What should be the approach for benchmarking Director’s
Remuneration?
Y Ltd
Rs.3X
Rs.7X
Mr B
Mr C
DOMESTIC TRANSFER PRICING
Interest to Partners
•
M/s AB & Co
12%
Partner A
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10%
Partner B
Benchmarking of payment of interest to partner – covered
under section 40(b)
- Is section 40A(2)/ transfer pricing applicable? Should
ALP be determined?
- Can 12% interest rate as provided by section 40(b), be
considered as ALP?
- Can payment of interest @ 15% be justified if ALP = 15%
or more? Can section 40(b) disallowance be made to the
extent of 3%?
- If ALP = 9%, is section 40(b) still applicable? If interest
is paid @ 12%, will 3% be disallowed?
- What will be the scenario in case of remuneration?
DOMESTIC TRANSFER PRICING
Close Connection u/s 80-IA(10)
•
Head
Office
Eligible Unit
u/s 80IA
Sale of
Goods
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Domestic Transfer Pricing
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•
•
Other Unit
Party With
Close
Connection
Sale of
Goods
•
•
•
Will Domestic TP be applicable to such a transaction
structure?
Close Connection under section 80-IA(10)
What if the intermediary does not have a close connection
with the taxpayer?
“any other reason” – section 80-IA(10)
Is the business transacted so arranged…?
Practical issues in reporting in Form 3CEB / justification of
arm’s length price?
DOMESTIC TRANSFER PRICING
Section 40A(2) Vs. Section 80-IA
A Ltd
Eligible for
80-IA
Payment of
Rent
Related
Parties
B Ltd
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Domestic Transfer Pricing
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•
Assume, arm’s length price of the rent paid is Rs. 100 Cr.
•
What if the transaction price is Rs. 80 Cr.?
•
What if the transaction price is Rs. 120 Cr.?
•
Practical issues in price setting!
DOMESTIC TRANSFER PRICING
What When Benchmarking Is Not Feasible
•
Exhaust all possible sources of benchmarking & documents
•
Demonstrate due diligence
•
Reliance on International Guidance
•
Reliance on Expert Opinions
•
Documentation for inter-company negotiations
•
Documenting complete transactional profile
•
Next best possible comparable (Lateral Comparable)
•
Earlier/subsequent year’s benchmark
•
Group level transfer pricing policies
•
Industry best practices
•
Compile robust documentation for each stage
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Domestic Transfer Pricing
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KEY TAKEAWAYS
CA Jiger Saiya
KEY TAKEAWAYS
Mitigate Transfer Pricing Risks
•
Expanded coverage
-
Expanded definition of AE and Enterprise
-
Capital transactions covered
-
Specified domestic transactions
-
Business Restructuring
•
No provision for revision of Form 3CEB
•
Increased penalty exposure
•
Importance of
•
-
Management Representation Letter and its coverage
-
Disclaimers in Documentation
DOCUMENTATION IS THE KEY
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Domestic Transfer Pricing
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THANK YOU
CA Jiger Saiya
Contact details
e: jigersaiya@bdo.in
t: +91-22-24393600
m: +91-93-23108666